Net domestic sales increased by c17.5% year-on-year (y-o-y) (as Q2 calendar year 15 was impacted by Maggi ban) and now Nestlé’s operating performance appears to be on the path of full recovery for the Maggi portfolio.
Net domestic sales increased by c17.5% year-on-year (y-o-y) (as Q2 calendar year 15 was impacted by Maggi ban) and now Nestlé’s operating performance appears to be on the path of full recovery for the Maggi portfolio. Exports increased by 7% y-o-y making an overall revenue increase of 16.7% y-o-y. Gross margin expansion was 214bp, while Ebitda margin expanded by 11bp, largely due to higher staff costs and other expenses as overall revenue is still below potential due to Maggi revenue, which is gradually coming back to normalcy. Sales growth momentum is picking up and likely to strengthen further buttressed by new product launches across categories to boost volume growth trajectory.
Investment case will increasingly depend on non-Maggi portfolio
Performance of the non-Maggi portfolio was disappointing in CY15. Maggie has made a rapid recovery claiming back 57% of market share, implying almost two-thirds of the Maggi revenue has already made a comeback. Leadership is focused on volume-led growth and product innovation. Recent launch of 25 new SKUs is clear evidence of renewed sense of energy and execution. In our view, the Maggi comeback has already been expected and factored into the stock price. Hence, Nestle’s investment case from here on will be driven by how much progress Nestle makes in delivering volume-led growth in other segments as well. We think Nestle, with strong brands and capabilities, has long-term “right to win” in its core segments. The pace of execution in the non-Maggi portfolio will continue to remain the main catalyst for the stock price, in our view .
We retain our Hold rating, but increase our target price to R6,800
After the sharp run in the stock price, current valuation multiple implies long-term annualised earnings growth expectation of 14%, which in our view is significantly high if not excessive and limits upside. Near-term outlook for earnings now appears solid as last year’s base is quite benign (due to the Maggi fiasco), which should lead to strong earnings growth. However, we believe it is the progress in the non-Maggi portfolio that will be instrumental as the stock catalyst from here on. We retain our Hold rating and increase our fair value target price TP to R6,800 (from R6,300) as we revise our estimates and roll our valuation forward.
We are marginally revising our estimates post Q2CY16 results as we increase CY16-18 earnings estimates by c1-2% while we increase our long term earnings growth estimates. We also roll forward our fair value estimate from April 2016 to July 2016. Change in estimates coupled with rolling our valuation forward results in a fair value estimate of R6,800 (from R6,300).
Valuation and risks
Our R6,800 TP is based on DCF methodology. We use a cost of equity of 9.5%, which assumes a risk-free rate of 3%, a market risk premium of 6.5%, a beta of 1, and terminal growth of 4% (all unchanged). Our target price of R6,800 implies downside of 6% to the current share price; therefore, we maintain a Hold rating as we believe that most of the downside has already been priced into the shares and the stock appears to be building in reasonable growth expectations.
Key downside risks: (i) Increased competitive intensity in key categories leading to loss of market share and hence lower revenue growth (ii) Maggi noodles volume growth acceleration below our estimates (iii) Increase in competitive intensity resulting in price based competition and lower than expected margins.
Key upside risks: (i) Maggi noodles volume growth picks up faster than expected (ii) acceleration of demand for packaged foods ahead of our estimates (iii) Strong focus on SKU level profitability leading to improvement in group margin profile.